Two months into 2020 and the only thing that appears certain is more uncertainty. Global economic growth is fairly weak and central banks continue to scramble for new tools to support jobs, trade and credit. Meanwhile, a viral pandemic is making its impact felt across global markets.
For now, however, there is a precarious stability priced into markets as fears of further weakness are balanced against some optimism over the potential resolution of the US-Sino trade dispute. Credit markets are likely to remain supported, but benchmark investors will have to see above-trend growth if they want another strong year of credit market returns.
Against this backdrop, we believe it is crucial to strike the right balance between holdings with the potential for high total return and those with more stable prices and steady income is, particularly in the high-yield market. In addition, diversifying one’s sources of return can also help mitigate portfolio volatility.
Income and capital
Our investment approach seeks to acquire high, consistent income while incurring less than half the risk of a dedicated high-yield strategy. The portfolio is actively-managed and adapts to changes in the interest rate and credit risk environment. It has a global remit that includes developing markets for the sake of income diversification, while emerging markets, including Asia, are also evaluated for opportunities.
Leveraging a diverse set of return drivers, our goal is to provide clients with opportunities for capital preservation and low correlation to equities. In order to achieve this, we take two main approaches to risk management, which are utilising a ‘core’ sleeve and a ‘plus’ sleeve within the portfolio.
The core sleeve consists of treasuries, agency mortgages and investment grade credit, which are designed to help mitigate volatility and drawdowns. The sleeve can range from 35% to 65% of holdings.
The ‘plus’ sleeve targets high, consistent income from high yield corporates, bank loans, asset-backed and commercial mortgage-backed securities as well as emerging debt. The correlation between the two sleeves is just 0.20, balancing risk between them with the aim of dampening volatility and delivering regular income.
Over the summer of 2019, the gap between the spreads of higher and lower-rated bonds accelerated dramatically. And while the higher BB-rated bonds returned an average of 15% last year, the lower-rated CCC segment failed to top 5% for much of the year until it experienced a sharp rally in December. This divergence illustrates the importance of strong company fundamentals in below-trend growth environments–and the need to alter exposures to maintain income and protect capital.
The CCC market has been shrinking and deservedly so. After a decade of economic expansion, companies that are still in the CCC category are being justifiably vetted by the market. Strong economic growth can mask many mistakes, while slower economic growth tends to unmask them.
Markets may yet come round to the view that credit markets are broadly overvalued, given the tightness of yields over US treasuries, and that some sectors are more over-valued than others. High yield is likely to remain suspended between US growth concerns, high valuations and the demand for yield. If any of those factors changes or deteriorates, valuations could be at risk.
Capturing the elusive
The current market environment has highlighted the importance of well-diversified strategies that have the expertise and resources to dynamically allocate between different sectors, without merely relying on a single sector such as high yield, emerging market debt or bank loans to provide returns. Given the uncertain landscape, we think it’s key to focus on yield that can be captured with minimal volatility and by seeking diversified sources of return to further mitigate portfolio volatility.
In our view, a combination of total return and steady income opportunities across all segments of fixed income will be critical in navigating an uncertain 2020.
Today’s uncertainty may cause you to question your investment strategy. But with the right perspective and investment solutions, we think it’s possible to stay focused on long-term goals.
Learn more about strategies to navigate uncertainty with Janus Henderson Investors.
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